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Large and Small Sellers: A Theory of Equilibrium Price Dispersion with Sequential Search

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  • Guido Menzio
  • Nicholas Trachter

Abstract

The paper studies equilibrium pricing in a product market for an indivisible good where buyers search for sellers. Buyers search sequentially for sellers but do not meet every seller with the same probability. Specifically, a fraction of the buyers' meetings lead to one particular large seller, while the remaining meetings lead to one of a continuum of small sellers. In this environment, the small sellers would like to set a price that makes the buyers indifferent between purchasing the good and searching for another seller. The large seller would like to price the small sellers out of the market by posting a price that is low enough to induce buyers not to purchase from the small sellers. These incentives give rise to a game of cat and mouse, whose only equilibrium involves mixed strategies for both the large and the small sellers. The fact that the small sellers play mixed strategies implies that there is price dispersion. The fact that the large seller plays mixed strategies implies that prices and allocations vary over time. We show that the fraction of the gains from trade accruing to the buyers is positive and nonmonotonic in the degree of market power of the large seller. As long as the large seller has some positive but incomplete market power, the fraction of the gains from trade accruing to the buyers depends in a natural way on the extent of search frictions.

Suggested Citation

  • Guido Menzio & Nicholas Trachter, 2014. "Large and Small Sellers: A Theory of Equilibrium Price Dispersion with Sequential Search," Working Paper 14-8, Federal Reserve Bank of Richmond.
  • Handle: RePEc:fip:fedrwp:14-08
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    References listed on IDEAS

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    1. Carlos Carrillo‐Tudela & Guido Menzio & Eric Smith, 2011. "Job Search With Bidder Memories," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 52(3), pages 639-655, August.
    2. Albrecht, James W & Axell, Bo, 1984. "An Equilibrium Model of Search Unemployment," Journal of Political Economy, University of Chicago Press, vol. 92(5), pages 824-840, October.
    3. Greg Kaplan & Guido Menzio, 2015. "The Morphology Of Price Dispersion," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 56(4), pages 1165-1206, November.
    4. Pissarides, Christopher A, 1985. "Short-run Equilibrium Dynamics of Unemployment Vacancies, and Real Wages," American Economic Review, American Economic Association, vol. 75(4), pages 676-690, September.
    5. Moen, Espen R, 1997. "Competitive Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 385-411, April.
    6. Rothschild, Michael, 1974. "Searching for the Lowest Price When the Distribution of Prices Is Unknown," Journal of Political Economy, University of Chicago Press, vol. 82(4), pages 689-711, July/Aug..
    7. Kenneth Burdett & Shouyong Shi & Randall Wright, 2001. "Pricing and Matching with Frictions," Journal of Political Economy, University of Chicago Press, vol. 109(5), pages 1060-1085, October.
    8. Curtis, Elisabeth & Wright, Randall, 2004. "Price setting, price dispersion, and the value of money: or, the law of two prices," Journal of Monetary Economics, Elsevier, vol. 51(8), pages 1599-1621, November.
    9. Alan T. Sorensen, 2000. "Equilibrium Price Dispersion in Retail Markets for Prescription Drugs," Journal of Political Economy, University of Chicago Press, vol. 108(4), pages 833-862, August.
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    Cited by:

    1. Guido Menzio & Nicholas Trachter, 2018. "Equilibrium Price Dispersion Across and Within Stores," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 28, pages 205-220, April.

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    More about this item

    Keywords

    Imperfect competition; Search frictions; Price dispersion;
    All these keywords.

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection

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